Cost Accounting

What is ABC analysis? Benefits and Drawbacks of ABC Analysis

ABC analysis is a method for classifying materials based on the quantity consumed and their relative values.

This method helps businesses prioritize their inventory based on its importance and significance, leading to several benefits.

Also referred to as “Selective Inventory Control.” Strategies based on an ABC analysis:

  • A ITEMS: stringent control and precise records
  • B ITEMS: less stringent controls and excellent records
  • C ITEMS: minimal controls and minimal documentation

The ABC analysis is a frequently employed inventory categorisation technique in which accuracy and control decrease from A to C. Some materials may be consumed in smaller quantities but for an extended time. These resources are stored in the group “A.” Similarly, certain materials may be consumed in big amounts but have reduced worth. These materials are stored in category C. In between these two extremes, certain items may be consumed in moderate quantities at moderate prices.

The ABC analysis provides a method for identifying items that will have a significant impact on overall inventory cost, as well as a method for identifying different stock categories that will require distinct management and controls.

The benefits of ABC analysis are that it can help managers make better decisions about inventory and allocate resources more efficiently. It can also help identify areas where cost savings can be made.

Benefits of ABC Analysis

The following are some of the advantages of ABC analysis:
a. Investment reduction: under ABC analysis, items from group “A” are purchased in the smallest quantities practicable. Efforts are also made to minimise the delivery time. These, in turn, serve to lower the material investment. It can help businesses save money by ensuring that they only purchase the most important items. Second, it can help businesses keep track of their inventory and ensure they have the items they need when needed. Finally, it can help businesses plan for the future and make sure that they have the right mix of inventory.
b. Strict control: under ABC analysis, the more valuable materials in group A can be subject to strict supervision. By identifying the most valuable items in stock, businesses can focus on ensuring optimal inventory levels of those products. This way, they will not be caught off guard by a sudden increase in demand.
c. Minimum storage costs: as materials from group ‘A’ are purchased in the smallest quantities possible, the storage costs are minimised as well.
d. Time savings: as a significant effort is made to manage the material from group ‘A,’ it also helps to save time.
e. Efficiency: By implementing the ABC method to control the flow of items in and out of a warehouse or distribution centre, companies can avoid overstocking in the supply of the items and reduce the likelihood of them running low

Limitations of ABC Analysis

The drawbacks of ABC analysis are that it can be time-consuming and expensive to implement, and it may not be suitable for all businesses. It can also create a sense of employee competition, which can lead to conflict. Other limitations are discussed below:

• An ABC analysis will be ineffective if the materials are not appropriately divided into groups.
• It is not ideal for organisations where material costs do not fluctuate dramatically.
• There is no scientific basis for classifying substances according to ABC analysis.
• Classifying the resources into distinct groupings may incur additional expenses. Consequently, it may not be appropriate for a small organisation.


The ABC analysis categorizes items into three groups: A, B, and C. Category A consists of high-value products that make up a small percentage of total inventory but contribute significantly to revenue. Category B includes mid-range products with moderate value and contribution to revenue, while category C contains low-value products with minimal contribution to revenue but high quantity in stock. By classifying inventory this way, businesses can focus on managing their most critical items more effectively.

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